Pensions

We’re all living longer, more active lives. Surely, worse than being afraid of dying too young must be the fear of living too long!

So, what should you do about planning for retirement and why is it so important to plan?

Britain has an ageing population and we all can expect to live longer than our forefathers.

The number of babies born each year remains constant whilst there are more and more pensioners relying on a smaller and smaller workforce to fund their State pensions. The single persons’ current basic State pension is just £90.70 a week (2008-09 figures), and that figure is set to fall in value compared to earnings in coming years. On top of this there will be less and less State pension money available to go around.

It is vital that we all make extra provision for our retirement through some form of savings vehicle. To encourage people to save for retirement, the Government allows very generous tax breaks on pension contributions. Basic rate taxpayers receive tax relief at 20% and higher rate taxpayers can receive relief at up to 40% (although higher rate taxpayers will not necessarily get 40% relief on single contributions). It makes sense to take advantage of a pension, one of the most tax-efficient ways of investing you will ever find. If you have an existing personal pension, when was the last time you had a Personal Pension Review?

The worst thing about pensions is their name. It conjures up all the wrong pictures. Instead, think of it as something that will pay you for not working later.

Personal Accounts

From 2012, all employers must offer a quality private scheme or subscribe to a Government backed Personal Account. Follow the link to our sister site for full information.

What type of pension scheme should I invest in now?

 If you are employed and your employer runs a company pension scheme it almost always makes sense to join it especially if your employer makes contributions in addition to your own. If your employer does not offer a company pension scheme, or if you are self-employed, you should consider a Stakeholder or personal pension plan.

If you are employed, you may be able to persuade your employer to make contributions too.

You can contribute to as many Stakeholder or Personal Pension plans as you like as long as you do not exceed the maximum levels for contributions set by the Inland Revenue.

From April 6th 2006 a new ‘simplified’ set of rules was applied to all UK pension arrangements. This swept away the eight existing tax regimes for pensions and replaced these with just one set of rules. Individuals are given greater choice and flexibility in when and how they save for their retirement. The intention of pension simplification was to remove complex calculations on what can be paid into a pension and what can be paid out at retirement. Following A-Day, whatever type of pension arrangement is concerned, individuals (and Employers) will be able to pay up to the Annual Allowance for that tax year (£235,000 for 2008-09), with an overall limit – the Lifetime Allowance (£1.65 million for 2008-09) for their total pension provision.

Within these limits full tax relief is available. For the few individuals where contributions made or funds are valued over these limits, they will either get no tax relief or will suffer a tax charge. The new rules allow for up to 25% of the pension fund to be taken as a Pension Commencement Lump Sum (PCLS) and this is currently tax-free, regardless of the type of pension. It may be relevant that this used to be called the "Tax Free Lump Sum". It is a matter for speculation as to whether or not his heralds a change to the tax status of this initial amount in the future.

Protection is available for existing pension schemes which exceed, or are likely to exceed these limits, but the schemes will need to be registered. There are many choices to be made by those who have existing pensions and for those considering how to start saving for retirement. Again, the issues are complex.

Stakeholder pensions were introduced in April 2001 to encourage those on lower incomes to make private provision for their retirement. They are generally available to anyone based in the UK. Stakeholder pensions are available for both employed and self employed people. For the first time, those without earned income, including children (or someone on their behalf!) are able to save into a pension plan. Most employers are obliged by law to offer a Stakeholder pension scheme to employees unless they already offer a pension scheme which meets certain standards.

The aim was that Stakeholder pensions will be straightforward, low-cost, flexible and transparent. The rules state that pension providers cannot charge plan holders more than 1.5% for the first ten years, then 1% in subsequent years.

Unfortunately, the very people that these plans were designed to help have been less than eager to participate and the more affluent have been quick to use them as very efficient tax planning tools to provide pensions for grandchildren!

How much should you contribute?

This depends on your age; be realistic. If you pay £50 a month into a pension, then do you really think it will provide an income of £20,000 a year when you retire? The arithmetic just isn’t there! The most important thing is for you to increase your contributions as your earnings increase.  If you wish to maximise your occupational pension scheme benefits you can do so by contributing to an Additional Voluntary Contribution (AVC) scheme run by your employer or a Personal Pension plan. The maximum contribution that can be paid to all schemes is your annual earnings, up to the £235,000 cap.

What income can I look forward to?

From a traditional occupational final salary scheme, also known as ‘defined benefit’, the amount of income you can expect each year is worked out using a set formula. The company might pay you, say, 1/60th of your final pay for every year you have worked there. For example, if you have worked for 25 years and your final salary is £25,000, you will receive 25/60ths of £25,000, which is £10,417 a year.

If you are in an occupational money purchase scheme, also known as ‘defined contribution’, your contributions and those made by your employer on your behalf are invested in funds, usually linked to the stock market. The return on your investment depends mainly on the performance and the type of funds you have chosen to invest in. The same applies with Stakeholder and Personal Pension plans. As with any long term investment, the value of funds can go down as well as up and past performance is no indication of future performance.

The Pensions Service have developed a guide and you can access it by following this link

Which is the right choice for me?

If your employer offers a company scheme which they pay into on your behalf, in most cases you should join it. Otherwise a Stakeholder or a personal pension plan is a sensible method of funding for retirement as these schemes will give you choices to match your preferences. You can also set up different types of pension plans should you want to, which was not allowed pre April 2006.

The sooner you get started making realistic pension contributions, the more comfortable your retirement is likely to be. The pension’s world remains complex and baffling for many consumers. Choosing the right pension provider, the most appropriate funds and agreeing an affordable level of contributions can be difficult to decide by yourself. Under the simplified pension regime from 6th April 2006 (A-Day), the limits to all pension arrangements in terms of what can be paid in and taken out have changed completely. We will be able to tell you whether and how these changes impact on you and if you need to take any action to protect your pension provision.

What if I already have a Personal Pension Plan?

A pension plan is an investment like any other, just with different tax breaks and conditions. Many people still have funds with providers that are now closed for new business and are paying charges way in excess of the Stakeholder standard and/or are in poorly performing funds or closed with profit funds which are paying virtually no bonus at all. Our section on With Profit Bonds gives some background to this problem.

Independent advice is essential here as a specialist can analyse your charges and funds and make recommendations for you to move your funds - often at no cost at all to yourself.

When must I take my benefits and how will they be paid?

Prior to Pension Simplification, an annuity had to be bought at the age of 75. This no longer applies, although for most people with modest pension pots and annuity remains the best choice. Alternatives are to leave the fund invested and take what is known as "Unsecured Pension" (USP). You can take up to 25% of the fund as tax free cash at the same time.

The USP upper limit is worked out using tables of income drawdown rates provided by the Government Actuary's Department (GAD).  The starting point is to work out the basis amount by multiplying the USP fund by the applicable rate from the GAD table (based on the pensioner's age and gender and the current gilt yield).

• The highest yearly income allowed is 120% of the basis amount.

• The lowest yearly income allowed is nil - that is, there is no need to actually receive any income, it is taken at the rate of £0.

Income can be changed each year within these upper and lower limits.

 At 75, you can continue to take what is known as an "Alternatively Secured Pension" (ASP), although the limits as to how much can be taken are not as generous. On death, the value of the fund may be returned to your estate, less a tax charge, or the surviving spouse may buy an annuity.

The ASP upper limit is again worked out using tables of income drawdown rates provided by the Government Actuary's Department (GAD).  The starting point is to work out the basis amount by multiplying the ASP fund by the applicable rate for a pensioner aged 75 from the GAD table (based on the pensioner's gender and the current gilt yield).

• The highest yearly income allowed is 90% of the basis amount.

• The lowest yearly income allowed is 55%of the basis amount.

• If unrealised funds pass to your estate, in addition to the potential of Inheritance Tax, a tax charge of up to 82% will be levied

Income can be changed each year within these upper and lower limits.

The great danger here is that more may be taken in income than the investment performance can sustain and you could literally outlive your pension fund. The option of leaving the money invested is therefore usually only recommended for funds >£100,000 and where the client has alternative income producing assets.

Taking Benefits Early

Every year one delays taking a pension may well mean that the fund continues to grow, but we can never, ever, live that year again and benefit from the income lost. For many people, taking benefits early makes good sense and we have developed a calculator to illustrate how this could affect you. If you would like us to discuss this with you, please contact us after having a look at the concept on our early retirement page